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on Central Banking |
| By: | Adrian Penalver; Daniele Siena |
| Abstract: | The paper shows, in a simple analytical framework, the existence of a deflationary bias in an economy with a low natural rate of interest, a Zero Lower Bound (ZLB) constraint on nominal interest rates and a discretionary Central Bank with an inflation mandate. The presence of the ZLB prevents the central bank from offsetting negative shocks to inflation whereas it can offset positive shocks. This asymmetry pushes average inflation below the target which in turn drags down inflation expectations and reinforces the likelihood of hitting the ZLB. We show that this deflationary bias is particularly relevant for a Central Bank with a symmetric dual mandate (i.e. minimizing deviations from inflation and employment), especially when facing demand shocks. But a strict inflation targeter cannot escape the suboptimal deflationary equilibrium either. The deflationary bias can be mitigated by targeting “shortfalls” instead of “deviations” from maximum employment and/or using flexible average inflation targeting. However, changing monetary policy strategy risks inflation expectations becoming entrenched above the target if the natural interest rate increases. |
| Keywords: | Monetary Policy Strategy, Inflation-Bias, Zero Lower Bound, Inflation Expectations. |
| JEL: | E52 E58 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:843&r= |
| By: | Mr. Zhongxia Zhang |
| Abstract: | Classical theories of monetary economics predict that real stock returns are negatively correlated with inflation when monetary policy is countercyclical. Previous empirical studies mostly focus on a small group of developed countries or a few countries with hyperinflation. In this paper, I examine the stock return-inflation relation under different monetary policy regimes and conditions using an expanded dataset of 71 economies. Empirical evidence suggests that the stock return-inflation relation is partially driven by monetary policy. If a country’s monetary authority conducts a more countercyclical monetary policy, the stock return-inflation relation becomes more negative. In addition, the results differ by monetary policy framework. In exchange rate anchor countries, stock markets do not respond to monetary policy cyclicality. In inflation targeting countries, stock markets react more strongly to inflation. A key contribution of this paper is to classify inflation targeters by their behaviors, and illustrate that behavior matters in shaping market perceptions: markets react to inflation and monetary policy cyclicality when central banks are able to control inflation within their target bands. In this case markets are sensitive to inflation dynamics when inflation is above the announced target bands. Finally, when monetary policy is constrained by the Zero Lower Bound (ZLB), a structural break is introduced and real stock returns no longer respond to inflation and monetary policy cyclicality. |
| Keywords: | monetary policy cyclicality; stock return-inflation relation; countercyclical monetary policy; market perception; inflation targeting country; Inflation; Stocks; Emerging and frontier financial markets; Inflation targeting; Central bank policy rate; Global |
| Date: | 2021–08–20 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2021/219&r= |
| By: | Bianchi, Francesco; Melosi, Leonardo; Rottner, Matthias |
| Abstract: | Since the 2001 recession, average core inflation has been below the Federal Reserve's 2% target. This deflationary bias is a predictable consequence of a symmetric monetary policy strategy that fails to recognize the risk of encountering the zero-lower-bound. An asymmetric rule according to which the central bank responds less aggressively to above-target inflation corrects the bias, improves welfare, and reduces the risk of deflationary spirals - a pathological situation in which inflation keeps falling indefinitely. This approach does not entail any history dependence or commitment to overshoot the inflation target and can be implemented with an asymmetric target range. A counterfactual simulation shows that a modest level of asymmetry would have removed the deflationary bias observed in the United States. |
| Keywords: | Asymmetric monetary policy,deflationary bias,deflationary spiral,target range,framework review |
| JEL: | E31 E52 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:402021&r= |
| By: | Mr. Sebastian Weber; Mirko Abbritti; Agostino Consolo |
| Abstract: | Standard New Keynesian (NK) models feature an optimal inflation target well below two percent, limited welfare losses from business cycle fluctuations and long-term monetary neutrality. We develop a NK framework with labour market frictions, endogenous productivity and downward wage rigidity (DWR) which challenges these results. The model features a non-vertical long-run Phillips curve between inflation and unemployment and a trade-off between price distortions and output hysteresis that change the welfare-maximizing inflation level. For a plausible set of parameters, the optimal inflation target is in excess of two percent, a target value commonly used across central banks. Deviations from the optimal target carry welfare costs multiple times higher than in traditional NK models. The main reason is that endogenous growth and DWR generate asymmetric and hysteresis effects on unemployment and output. Price level targeting or a Taylor-rule responding to the unemployment rate can handle better the asymmetric and hysteresis effects in our model and deliver significant welfare gains. Our results are robust to the inclusion of the effective lower bound on the monetary policy interest rate. |
| Keywords: | NK model; inflation level; invariance hypothesis; target value; target carry welfare cost; Inflation targeting; Inflation; Wage rigidity; Wages; Wage adjustments; Global |
| Date: | 2021–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2021/208&r= |
| By: | Angelo Baglioni (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore); Andrea Monticini (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore); David Peel |
| Abstract: | We study the impact of ECB’s supervisory announcements on the Bank Stock index, from 2013 through 2017. Our evidence shows that the news, related to supervisory actions, do have highly significant effects on the market price of banks, contributing to the volatility of the Bank Stock Index for Europe and Italy. Most announcements signal the need to raise more regulatory capital and lead to negative returns in the stock market, thus increasing the cost of raising new capital. Our study is related to previous ones (by Bernanke and Kuttner) focusing on the impact of monetary policy announcements on the stock exchange. |
| Keywords: | Banking Supervision, ECB, GARCH, Stock Market. |
| JEL: | G21 G28 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:ctc:serie1:def112&r= |
| By: | Riccardo De Bonis (Bank of Italy); Giuseppe Ferrero (Bank of Italy) |
| Keywords: | central bank digital euro, history of money, payment system, digitalization, digital euro |
| JEL: | E42 E58 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:anc:wmofir:170&r= |
| By: | Breitenlechner, Max; Georgiadis, Georgios; Schumann, Ben |
| Abstract: | We quantify spillbacks from US monetary policy based on structural scenario analysis and minimum relative entropy methods applied in a Bayesian proxy structural vector-autoregressive model estimated on data for the time period from 1990 to 2019. We find that spillbacks account for a non-trivial share of the overall slowdown in domestic real activity in response to a contractionary US monetary policy shock. Our analysis suggests that spillbacks materialise as Tobin’s q/cash flow and stock market wealth effects impinge on US investment and consumption. Contractionary US monetary policy depresses foreign sales of US firms, which reduces their valuations/cash flows and thereby induces cutbacks in investment. Similarly, as contractionary US monetary policy depresses US and foreign equity prices, the value of US households’ portfolios is reduced, which triggers a drop in consumption. Net trade does not contribute to spillbacks because US monetary policy affects exports and imports similarly. Finally, spillbacks materialise through advanced rather than emerging market economies, consistent with their relative importance in US firms’ foreign demand and US foreign equity holdings. JEL Classification: F42, E52, C50 |
| Keywords: | Bayesian proxy structural VAR models, spillbacks, spillovers, US monetary policy |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20212613&r= |
| By: | Juan Yepez |
| Abstract: | Dutch disease is often referred as a situation in which large and sustained foreign currency inflows lead to a contraction of the tradable sector by giving rise to a real appreciation of the home currency. This paper documents that this syndrome has been witnessed by many emerging markets and developing economies (EMDEs) as a result of surges in capital inflows driven by accommodative U. S. monetary policy. In a sample of 25 EMDEs from 2000-17, U. S. monetary policy shocks coincided with episodes of currency appreciation and a contraction in tradable output in these economies. The paper also shows empirically that the use of capital flow measures (CFMs) has been a common policy response in several EMDEs to U.S. monetary policy shocks. Against this background, the paper presents a two sector small open economy augmented with a learning-by-doing (LBD) mechanism in the tradable sector to rationalize these empirical findings. A welfare analysis provides a rationale for the use of CFMs as a second-best policy when agents do not internalize the LBD externality of costly resource misallocation as a result of greater capital inflows. However, the adequate calibration of CFMs and the quantification of the LBD externality represent important implementation challenges. |
| Keywords: | monetary policy shock; LBD externality; Dutch disease effect; emerging markets and developing economies; EMDEs monetary policy framework; Dutch disease; Capital inflows; Exchange rates; Exchange rate arrangements; Global |
| Date: | 2021–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2021/209&r= |
| By: | Yizhi Xu; Samuel Mann; Pierre Guérin; Ken Zhi Gan; Manchun Wang; Mr. Adolfo Barajas; Woon Gyu Choi |
| Abstract: | After a steady increase following the global financial crisis, private nonfinancial sector leverage rose further during the COVID-19 on the back of easy financial conditions induced by unprecedented policy support. We investigate the empirical relationships between increased leverage, financial conditions, and macro-financial stability in a sample of major advanced and emerging market economies. We find that loose financial conditions contribute to leverage buildups and generate an intertemporal tradeoff: financial stability risk is lessened in the near term but exacerbated in the medium term. The tradeoff is amplified during credit booms, when debt service burdens are particularly high, or when the share of foreign currency debt is high in emerging markets. Selected macroprudential tools can arrest leverage buildups and mitigate the tradeoff. |
| Keywords: | leverage buildup; A. Macroprudential policy; loose financial conditions; Policy implication; B. Macroprudential policy; Credit booms; Macroprudential policy; Central bank policy rate; Macroprudential policy instruments; Financial sector stability; Global |
| Date: | 2021–08–20 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2021/222&r= |
| By: | Tischer, Johannes |
| Abstract: | The Eurosystem's Public Sector Purchase Programme (PSPP) increased the scarcity of safe assets, which caused significant declines and substantial dispersion in European repo rates. However, banks holding these safe assets benefited from this development: First, using the German security register, this paper shows that scarcity affects bank funding costs, as their collateral supply is determined by their ex ante securities holdings and repo rates. Second, it makes use of the German credit register to show that asset scarcity had real effects: Banks more exposed to asset scarcity increased their credit supply. |
| Keywords: | Quantitative easing,safe asset scarcity,repo rates,bank lending,monetary transmission |
| JEL: | E51 E58 G11 G21 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:352021&r= |
| By: | Singh, Aarti; Suda, Jacek; Zervou, Anastasia |
| Abstract: | We study the effects of monetary policy shocks on the growth rates of hiring, employment and earnings of new hires across firms of different sizes. We find that contractionary and expansionary monetary policy shocks have different effects on hiring and employment growth for small and large firms. Relative to large firms, small firms are less responsive to contractionary monetary policy shocks while they are more responsive to expansionary shocks. We also find that, as a consequence of monetary policy shocks, the earnings of new hires changes, and this wage effect depends on the sign of the shock and the size of the firms. We use a heterogeneous firm model with a working capital constraint, an upward sloping marginal cost curve and a financial accelerator effect, and augment it with the wage effect. We find that our empirical results are consistent with the model as long as the combined effect due to varying steepness of the marginal cost curve and the wage effect is stronger than the financial accelerator channel. |
| Keywords: | Heterogeneous firms, financing constraints, labour market, monetary policy |
| Date: | 2021–10 |
| URL: | http://d.repec.org/n?u=RePEc:syd:wpaper:2021-07&r= |
| By: | An, Sungbae (KOREA INSTITUTE FOR INTERNATIONAL ECONOMIC POLICY (KIEP)); Kang, Tae Soo (Korea Advanced Institute of Science and Technology (KAIST)); Kim, Kyunghun (Hongik University); Kang, Eunjung (KOREA INSTITUTE FOR INTERNATIONAL ECONOMIC POLICY (KIEP)) |
| Abstract: | In 2010, Korea's authorities announced foreign exchange-related macroprudential measures (MPMs) aimed at building resilience against external financial shocks. These measures have greatly contributed to limit systemic risk by curbing excessive capital inflows. Twelve years have passed since the global financial crisis started and ten years after the introduction of Korea's FX-related macro-prudential policy measures. Accordingly, this study check the performance and effectiveness of these policies and discuss how to improve macroprudential measures in response to emerging external risks. |
| Keywords: | Korea; capital flow; macroprudential; policy; risk |
| Date: | 2021–03–03 |
| URL: | http://d.repec.org/n?u=RePEc:ris:kiepwe:2021_006&r= |
| By: | Ruipeng Liu (Department of Finance, Deakin Business School, Deakin University, Melbourne, VIC 3125, Australia); Rangan Gupta (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa); Elie Bouri (School of Business, Lebanese American University, Lebanon) |
| Abstract: | Theory suggests the existence of a bi-directional relationship between stock market volatility and monetary policy rate uncertainty. In light of this, we forecast volatilities of equity markets and shadow short rates (SSR) - a common metric of both conventional and unconventional monetary policy decisions, by applying a bivariate Markov-switching multifractal (MSM) model. Using daily data of eight advanced economies (Australia, Canada, Euro area, Japan, New Zealand, Switzerland, the UK, and the US) over the period of January, 1995 to March, 2021, we find that the bivariate MSM model outperforms, in a statistically significant manner, not only the benchmark historical volatility and the univariate MSM models, but also the Dynamic Conditional Correlation-Generalized Autoregressive Conditional Heteroskedasticity (DCC-GARCH) framework, particularly at longer forecast horizons. This finding confirms the bi-directional relationship between stock market volatility and uncertainty surrounding conventional and unconventional monetary policies, which in turn has important implications for academics, investors and policymakers. |
| Keywords: | Shadow short rate uncertainty, Stock market volatility, Markov-switching multifractal model (MSM), Forecasting |
| JEL: | C22 C32 C53 D80 E52 G15 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:202178&r= |
| By: | Malik Shukayev; Alexander Ueberfeldt |
| Abstract: | The financial sector bailouts seen during the Great Recession generated substantial opposition and controversy. We assess the welfare benefits of government-funded emergency support to the financial sector, taking into account its effects on risk-taking incentives. In our quantitative general equilibrium model, the financial crisis probability depends on financial intermediaries’ balance sheet choices, influenced by capital adequacy constraints and ex ante known emergency support provisions. These policy tools interact to make financial sector bailouts welfare improving when capital adequacy constraints are consistent with the current Basel III regulation, but potentially welfare decreasing with looser capital adequacy regulation existing before the Great Recession. |
| Keywords: | Financial institutions; Financial stability; Financial system regulation and policies |
| JEL: | E44 D62 G01 E32 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:21-56&r= |
| By: | Biagio Bossone |
| Abstract: | This article investigates how the role that banks play in the payment system space affects their money creation power and process. In particular, the article analyzes how the payments market share of each bank affects its money creation power and how payment settlement technologies and rules determine the banks’ demand for funding and, hence, their money creation power. Also, as the power to create money enables money creators to extract extra-profits or rents ("seigniorage") from the economy, the article evaluates analytically how banks extract seigniorage through money creation and how bank seigniorage differs from profits from pure financial intermediation. By showing the central role that payment systems play in the context of such an important economics topic as money creation, the article seeks to emphasize the relevance of payment system analysis for macroeconomic theory and practice and points to the need for achieving better integration of the two disciplines. |
| Keywords: | Bank; Bank money creation; Central bank policy; Demand deposits; Financial intermediaries; Funding; Lending; Payment and settlement systems |
| JEL: | E51 E58 G21 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:pke:wpaper:pkwp2117&r= |
| By: | Mr. Thierry Tressel; Xiaodan Ding |
| Abstract: | Corporate sector vulnerabilities have been a central policy topic since the outset of the COVID-19 pandemic. In this paper, we analyze some 17,000 publicly listed firms in a sample of 24 countries, and assess their ability to withstand shocks induced by the pandemic to their liquidity, viability and solvency. For this purpose, we develop novel multi-factor sensitivity analysis and dynamic scenario-based stress test techniques to assess the impact of shocks on firm’s ability to service their debt, and on their liquidity and solvency positions. Applying the October 2020 WEO baseline and adverse scenarios, we find that a large share of publicly-listed firms become vulnerable as a result of the pandemic shock and additional borrowing needs to overcome cash shortfalls are large, while firm behavioral responses and policies substantially help overcome the impact of the shock in the near term. Looking forward, while interest coverage ratios tend to improve over time after the initial shock as earnings recover in line with projected macroeconomic conditions, liquidity needs remain substantial in many firms across countries and across industries, while insolvencies rise over time in specific industries. To inform policy debates, we offer an approach to a triage between viable and unviable firms, and find that the needs for liquidity support of viable firms remain important beyond 2020, and that medium-term debt restructuring needs and liquidations of firms may be substantial in the medium-term. |
| Keywords: | Covid-19 pandemic, corporate sector vulnerabilities, stress tests, debt restructuring, viability of firms, solvency and liquidity support policies.; A. firm Level vulnerability indicator; pandemic shock; liquidity support policy; debt share; share of sample; COVID-19; Currencies; Stress testing; Liquidity; Financial statements; Global; Africa |
| Date: | 2021–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2021/212&r= |
| By: | Kiichi Tokuoka; Mr. Jongsoon Shin; Yudong Rao; Michael Perks |
| Abstract: | This paper makes contributions to the study of bilateral swap lines (BSLs). First, this paper fills a BSL information gap by constructing a comprehensive database of BSLs based on publicly available information, including after the onset of the COVID-19 pandemic. Second, the paper provides the results of regression analysis exploring several empirical questions that were not covered in previous studies. The paper documents the evolution of BSLs into an important part of the Global Financial Safety Net (GFSN), with some helping to stabilize financial market during both the Global Financial Crisis (GFC) and the COVID-19 pandemic. Analysis suggests that countries on the recipient side of BSLs are more likely to sign and renew BSLs designed to alleviate balance of payments needs as their external position weakens. U.S. Federal Reserve BSLs appear to have been effective at stabilizing financial market conditions during the COVID-19 pandemic. |
| Keywords: | Bilateral swap lines (BSLs); Global Financial Safety Net (GFSN); COVID-19 pandemic; Global Financial Crisis (GFC); BSL information gap; Federal Reserve BSL; Fed swap network; BSL network; Fed's BSLs; liquidity swap operations; information gap; Current account balance; COVID-19; Credit default swap; Currencies; Global; Asia and Pacific |
| Date: | 2021–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2021/210&r= |
| By: | Karim McDaniels; Nico Palesch; Sanjam Suri; Zacharie Quiviger; John Walsh |
| Abstract: | The investment of foreign exchange reserves or other asset portfolios requires an assessment of the credit quality of investment counterparties. Traditionally, foreign exchange reserve and other asset managers relied on credit rating agencies (CRAs) as the main source of information for credit assessments. In October 2010, the Financial Stability Board issued principles to reduce reliance on CRA ratings in standards, laws and regulations, in support of financial stability. Moreover, best practices in the asset management industry suggest that investors should understand the credit risks they are exposed to and, more broadly, that they should rely on internal credit assessments to inform investment decisions. In support of these objectives, the Bank of Canada first published its sovereign rating methodology in 2017. It provided a detailed technical description of the process developed to assign internal credit ratings to sovereigns, using only publicly available data. This publication updates the internal sovereign rating methodology to stay abreast of evolving best practices and leverage internal experience. This updated methodology proposes three key innovations: (i) a new approach to assessing a sovereign’s fiscal position, (ii) adjustments to the approach to assessing monetary policy flexibility and (iii) the explicit consideration of climate-related factors. |
| Keywords: | Credit risk management; Foreign reserves management |
| JEL: | G28 G32 F31 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:21-16&r= |
| By: | Leonardo Nogueira Ferreira |
| Abstract: | This paper explores the complementarity between traditional econometrics and machine learning and applies the resulting model – the VAR-teXt – to central bank communication. The VAR-teXt is a vector autoregressive (VAR) model augmented with information retrieved from text, turned into quantitative data via a Latent Dirichlet Allocation (LDA) model, whereby the number of topics (or textual factors) is chosen based on their predictive performance. A Markov chain Monte Carlo (MCMC) sampling algorithm for the estimation of the VAR-teXt that takes into account the fact that the textual factors are estimates is also provided. The approach is then extended to dynamic factor models (DFM) generating the DFM-teXt. Results show that textual factors based on Federal Open Market Committee (FOMC) statements are indeed useful for forecasting. |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:559&r= |
| By: | Christopher Roth (University of Cologne, ECONtribute, C-SEB, briq, CESifo, CEPR, CAGE); Mirko Wiederholt (LMU Munich and Sciences Po, CESifo, CEPR); Johannes Wohlfart (Department of Economics and CEBI, University of Copenhagen, CESifo, Danish Finance Institute) |
| Abstract: | We study the effects of forward guidance with an approach that combines theory with experimental estimates of counterfactual expectation adjustments. Guided by the model, we conduct experiments with representative samples of the US population to study how households adjust their expectations in response to changes in the Fed’s projections about future interest rates. Respondents significantly downward-adjust their inflation expectations in response to learning about an increase in the Fed’s pro-jection about the federal funds rate three years in the future, and they expect inflation to respond most strongly immediately after the announcement. By contrast, respon-dents do not adjust their nominal income expectations. Our model-based estimates highlight a small average consumption response to forward guidance due to oppos-ing effects from intertemporal substitution and changes in expected real income. |
| Keywords: | Expectation Formation, Information, Updating |
| JEL: | D12 D14 D83 D84 E32 G11 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:126&r= |
| By: | Ryuichiro Hirano (Bank of Japan); Yoshihiko Hogen (Bank of Japan); Nao Sudo (Bank of Japan) |
| Abstract: | In the Financial System Report, the Bank of Japan monitors developments of the Financial Activity Indexes (FAIXs), which showed large deviations from the trend during Japan fs bubble period of the late 1980s, as a means to detect early warning signals of financial imbalances caused by overheating of domestic financial activities. This article constructs corresponding FAIXs in 17 countries and asks if they are able to predict a banking crisis in these countries. The result shows that among the FAIXs, total credit to GDP ratio, which is an indicator that is considered to capture credit activities of the private sector as a whole, has a reasonable degree of predictive power for these crises. The nature of banking crises differs, however, and these indicators do not necessarily have high predictive power for banking crises that occur when domestic financial activity is not overheated. In addition, the probability of a banking crisis occurring rises when the "red" signal of the total credit to GDP ratio lasts for a prolonged period or when this "red" signal happens together with "red" signals of other indicators. |
| Keywords: | Financial Imbalance; Banking Crisis; Heat map |
| JEL: | G01 G21 G32 |
| Date: | 2021–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:boj:bojrev:rev21e05&r= |